Healthscope on the KKR radar

The reports that US private equity giant KKR, advised by Morgan Stanley, is circling private hospital operator
Healthscope
look to be bang on the money.

The big question is whether KKR can gain an edge over the $1.8 billion bid that rival private equity firms TPG, The Carlyle Group and Blackstone have already tabled.

Industry speculation suggests that KKR isn’t acting entirely alone. The talk is centring around KKR structuring its offer to include a break-up of Healthscope, which would involve teaming the company’s radiology arm with the country’s largest private diagnostic imaging business, the CVC Asia Pacific-owned I-Med.

I-Med operates over 220 diagnostic imaging clinics across Australia and performs more than 4.5 million examinations annually. Healthscope’s in-hospital radiology business would create synergies for private-equity run I-Med, as it would increase its access to patients.

I-Med was formally the listed DCA Group, which CVC Asia Pacific later renamed following its 2006 acquisition.

KKR is said to see an acquisition of Healthscope as an entry point into the Australian healthcare market. And doing a deal with CVC’s I-Med business is not the only option.

There is also talk that KKR could offload Healthscope’s pathology business, on a state-by-state basis, to rivals
Sonic Healthcare
and
Primary Health Care
.

If KKR pursues this strategy, the idea will be for Sonic and Primary to pay a premium for the pathology businesses in various states, and in doing so, gain market share.

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Sonic and Primary have very strong positions in terms of pathology market share in the large NSW and Queensland markets, while Healthscope has a strong share in Victoria and South Australia.

But there are likely to be competition issues in Victoria, where Primary, Healthscope and Sonic hold respective market shares of 30 per cent, 21 per cent and 18 per cent.

As an aside, it’s worth noting that KKR is unlikely to join the Carlyle, Blackstone and TPG consortium as it can self-fund the takeover through a split of mezzanine funding and debt, and can potentially offer a higher price by arranging side deals with trade buyers.

However, industry sources say a merged KKR/I-Med could fall foul of the Trade Practices Act, which means KKR could be selective in which assets it decides to divest from the two businesses.

Meanwhile, Healthscope is entertaining the consortium’s offer and on Tuesday, granted the TPG, Carlyle and Blackstone bid due diligence, which is expected to lead to a formal offer.

TPG, Carlyle and Blackstone indicated they would be prepared to pay $1.82 billion or $5.75 a share pending due diligence, after TPG and Carlyle’s lower offer of $5.50 a share was rebuffed.

A rival bid could create pricing tension and allow Healthscope’s board to negotiate a higher bid. If completed, the deal would be Australia’s largest-ever private equity buyout.

The TPG-Carlyle-Blackstone consortium is being advised by UBS, Credit Suisse, Macquarie Capital and Barclays Capital. Deutsche Bank and Merrill Lynch have also joined the banks assisting the deal.

Goldman Sachs JBWere and Lazard are advising the Healthscope board.

Strategic rationale aside, it’s unusual to see private equity firms go head to head for a publicly-owned company. So why all the interest in Healthscope?

Private equity has successfully invested in offshore private hospital businesses, and from the outside, Healthscope’s strong market position and Australia’s ageing population make a strong argument.

However, the industry has had its own share of problems. All the major players – Healthscope, Primary and Sonic – are trying to recover revenue lost through the government’s decision to cut $763 million from pathology funding over four years.

Pathology revenue accounts for 16 per cent of Healthscope’s earnings before interest, tax, depreciation and amortisation, compared with the 38 per cent contribution to earnings from pathology at Sonic, which announced an 8 per cent downgrade to full-year earnings last week.

Primary warned its earnings would be between $15 million and $25 million below last year’s $355 million result.

Despite the potential corporate action brewing around Healthscope, it’s thought unlikely Primary and Sonic could also be takeover targets.

The 40 per cent drop in Primary’s share price so far this year has some saying that it could be ripe for takeover. But others say this is unlikely due to Primary’s tightly held share register, and the fact that the business is largely controlled by chief executive
Ed Bateman
.

His older son James Bateman heads Primary’s pathology business, while younger son Henry Bateman is general manager of medical centres.

Meanwhile, Sonic is likely to be attractive to global private equity players given its strong offshore presence.

Market rumours have suggested United States-based diagnostic testing giant Quest Diagnostics could be a possible bidder, given it recently flagged expansion aspirations. But analysts believe the acquisition could be too big for Quest for the time being.

Quest has a market capitalisation of about $US9.5 billion ($11.3 billion), compared with Sonic, which has a market cap of about $3.8 billion.